Monday, September 12, 2011

Tinkering at the margins

Still swamped with work, but time for a quick post to reward myself for getting my dissertation proposal approved...

Harvard profs Greg Mankiw and Robert Barro, two giants of the macro world, have twin editorials in the NYT suggesting what we should do to improve the economy. Mankiw favors free trade agreements and steps to improve international wage competitiveness...

Myriad government actions influence the expected future profitability of capital. These include not only policies concerning taxation but also those concerning trade and regulation.

For example, passing the free trade agreement with South Korea, which has languished in Congress more than four years after first being negotiated, would be a step in the right direction. So would reining in the National Labor Relations Board; its decision to block Boeing from opening a nonunion plant in South Carolina may have been hailed by organized labor, but it surely did not hearten investors.

...while Barro suggests switching from corporate and estate tax to a VAT:

A broad-based expenditure tax, like a VAT, amounts to a tax on consumption. If the base rate were 10 percent, the revenue would be roughly 5 percent of G.D.P. One benefit from a VAT is that it is more efficient than an income tax — and in particular the current American income tax system...

Abolishing the corporate income tax is similarly controversial. Any tax on capital income distorts decisions on saving and investment.

Now, I broadly agree with all the policies described above (yes, including allowing South Carolina to compete with Washington state on wages). But do prof.'s Mankiw & Barro really believe that these will get us our of our slump? Where have we seen an example of a country that got itself out of recession by tweaking its tax and labor policies? I can't think of one. Europe has a VAT and a corporate tax rate that is 15 percentage points lower than ours, and they don't seem to have made a quick exit from this slump. Maybe FTAs will have more of a countercyclical effect, but it's important to remember that Korea is one-seventh our size.

And another point. All of these policy suggestions are structural things. They are one-off policies that cannot be repeated. Even if improving tax policy helps us out of this recession, what do we do when the next recession comes along? Now, maybe Mankiw and Barro don't believe that real countercyclical policy exists, and that instead the best we can hope for is that crises will make needed structural changes politically feasible. But then I think they should say this. (Update: Brad DeLong agrees.)

As for me, I doubt that these tweaks will have much of an effect. What do I think will? Well, my hunch - and this is just a hunch - is that we should start taking a very hard look at exchange-rate policy...but that is a blog post for another day...

(Note: Barro also makes an argument for fiscal austerity. I'm not going to get into that now, except to say that the approval I expressed toward his tax policy ideas do not extend to his call for austerity. Just in case anyone was wondering.)

Thank you! For both taking Mankiw to task and raising the point about exchange rate policy.

On Mankiw...it's pathetic how he failed to mention the debt overhang in his op-ed. He just talked about how businesses are not spending. What I really can't stand about Mankiw is his faux-centrism (he has to appear centrist to keep milking his textbook cashcow). Barro has always held staunchly right-wing political views on economic issues and a big fan of RE. But Mankiw writes as if he has not a clue of what Rogoff has been drumming on about all this time...except that he does and he even uses the same macro model as Rogoff.

On exchange rate policy...I agree that we need to focus on weak dollar, reversing capital flows, and making the savers (Japan, China, Germany, etc) spend and allow the spenders to deleverage and export simultaneously. The question is how do we effectively engage in exchange rate policy. We could place a tariff on China until they have a credible pathway to a floating currency. I don't see it ever happening where the Fed behaves like the BoJ or the SNB in actively seeking to weaken the dollar. Thus, it all comes back to QE3. I say buy out the long end of the treasury curve and push financial capital abroad. That will weaken the dollar, albeit in a backdoor manner.

I was struck by the quote: "Any tax on capital income distorts decisions on saving and investment."

I can think of lots of things that distort decisions on saving and investment. For example, poverty, lack of education, or having fatal cancer or heart disease but no medical insurance. These things seriously distort nearly every aspect of potentially productive human lives.

How about getting rid of corporate income tax, but taxing capital gains, dividends, and interest at the normal income tax rates?

Honestly? Free trade and changing from a corporate income tax to a value added tax are going to solve a problem of seriously depressed aggregate demand? If something could be done to accelerate the household debt deleveraging process or there was a seriously large and probably sustained stimulus, that should be able to cure the temporary (but long-lasting) shortfall.

I'm trying to develop ideas along this line in <a href="http://socialmacro.blogspot.com/>my own blog</a>.

I have my doubts about the relative effectiveness of quantitative easing and certainly the potential for establishing credibility to raise the rate of inflation in the U.S. economy. My main problem with it is that if the financial markets realize that the U.S. is in a liquidity trap, they will realize that the Federal Reserve cannot deliver on the promise of higher inflation in the relative short-term, so there is little reason why they would buy the Fed's promise of higher inflation. I hope I'm wrong and I might be, especially if economic actors have a worse model of the economy functioning in their heads.

The problem with the Republican talking points is:1) The cost of capital is historically low.2) Given that businesses finance themselves in part with effectively tax free borrowing from pension funds and iras the real tax rate they face on new investments is so low that it is unlikely to be a hurdle for new investment.3) When companies would rather invest cash reserves at zero return than invest it at some return and pay 10 to 30% tax on that return you know the problem is lack of opportunities, not the tax rate.

The Republicans have been shifting the burden to the middle class for thirty years and it is tearing the US apart.

Oh come on. "Any tax on capital income distorts decisions on saving and investment." Well sure, any tax on anything distorts some decision (so we shouldn't have any right?) but this line is always brought out to push changes to help the rich get richer. Look, if the primary concern is making sure businesses are profitable and returns to capital are good, then why are we talking about the economy so much when clearly the recession has been over for some time? This just does not address a problem we have.

Here's the other thing that bugs me... middle class wages have been stagnant for 30 years, and the plan is we need to make them lower? Too many economists like to treat labor like any resource, as a cost to be minimized to make the economy as productive as possible. Problem is wages are absolutely essential to making sure an economy actually serves its people, and that will continue to be the case for as long as wages are the primary source of income for most people. Barring a radical change in how our economy works, higher wages ought to be as important of a goal as higher GDP.

But even if you don't accept higher wages as an end, the lack of middle class wage growth has been at the root of much of our problems. Increased savings at the top has meant a bigger financial sector, easier credit for the middle class, and stagnant wages have meant more incentive to go into debt. A demand shortfall isn't going to be fixed without restoring the middle class.

"Here's the other thing that bugs me... middle class wages have been stagnant for 30 years, and the plan is we need to make them lower? Too many economists like to treat labor like any resource, as a cost to be minimized to make the economy as productive as possible."

Productivity is great if you can afford the highly productively made goods. With the cost of health care exploding, those who have been losing real income can't.